Loans to Directors by a Company is governed by Section 185 of the Companies Act, 2013. This Section deals with prohibitions, relaxations and exemptions relating to lending of loan and providing guarantee and security. It also deals with the penalty for contravention of the provisions of the section.
The original Section prohibited the companies from advancing any loan and/or giving any security or guarantee in relation to the loan taken by the Directors of the company or any other person in whom the Director is interested. If found guilty of non-compliance, penalties were allowed not only against the erring companies but also on the borrowers of such loans.
Companies (Amendment) Act, 2017 amended the section to its current state. As per Subsection (1) of Section 185, no company shall, directly or indirectly, advance any loan, including any loan represented by a book debt, to any of its directors or to any other person in whom the director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person.
The proviso to the sub-section provides that the restrictions shall not apply in the following cases:
- Loans to Managing Director & Whole Time Director – As part of conditions of service extended by the company to all its employees; or pursuant to any scheme approved by the members by a special resolution.
- In the ordinary course of its business – Loans / Guarantees / Securities in respect of which an interest is charged at a rate not less than the bank rate.
- Loans to Subsidiary Companies – Any loan /guarantee / security provided by a holding company to its wholly owned subsidiary company.
- Loans given by Banks and Financial Institutions to Subsidiaries – to any guarantee given or security provided by a holding company in respect of loan made by any bank or financial institution to its subsidiary company
It was further provided that that the loans made under clauses (c) and (d) are utilised by the subsidiary company for its principal business activities.
In case of any contravention of the Section:
- The company shall be punishable with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees
- Director or the other person to whom any loan / guarantee / security is given shall be punishable with imprisonment which may extend to six months or with fine which shall not be less than five lakh rupees which may extend to twenty-five lakh rupees, or with both
Section 185 should be read with section 186 to analyze both the provisions better as section 185 may be rendered inoperative if the provisions of section 186 are read separately. As both the sections are in conflict with each other, the rule of Harmonious Construction must be applied to the current situation for a better understanding of the section. The Hon’ble Supreme Court in a Landmark case has stated that a statute must be read as a whole and one provision of the Act should be constructed with reference to other provisions in the same Act so as to make a consistent enactment of the whole statute. In other words, when there are two provisions in a statute, which are in conflict with each other, they should be interpreted such that effect can be given to both and the construction which renders either of them inoperative and useless should not be adopted except in the last resort.